Enron was felled by its accounting gimmicks. Now it appears such gimmicks are part of how Lehman Brothers fell and dragged the global financial system with it. On Thursday, a US court released a report showing how clever accounting proved too clever for Lehman’s own good.
Just as Enron used special purpose vehicles to hide debt, Lehman moved debt off its balance sheet. Exploiting an accounting loophole, it showed a repurchase transaction—a short-term deal where it temporarily transfers an asset as loan collateral—as the actual sale of the asset.
As of now, this appears legal. Then again, we imagine clever accounting usually involves someone proving that a questionable transaction is legal. That may mean regulators can’t intervene, but that only shifts the burden onto the firms.
One, it means a firm’s board and managers should manage risk through, say, more thorough internal audits. Two, it means executives shouldn’t have incentives—say, skewed compensation—to hide that risk. Most of all, it means a good company won’t rely on regulators to do its own job.